OTC Derivatives Market

“Size is too simple a metric… It really doesn’t matter from a systemic point of view whether you have four banks or forty banks in a market. It’s the system’s asset concentration – principally in government debt and in mortgage debt – that can be dangerous.”

Thought of sharing some Important glossary on the OTC Market as I was refreshing self on last night :

Collateral management : Typically, two parties enter into an OTC transaction under an Agreement(ISDA framework mainly) that specifies the contractual relationship between the two parties. As part of this Agreement, a specific document (Credit Support Annex/Deed under the ISDA framework) stipulates that some collateral will be exchanged between them to mitigate counterparty risk. Collateral, in the form of cash or securities, is mainly exchanged on the basis of the variation in the value of the exposure between the parties (value of all OTC contracts under the Agreement). This is often referred to as Variation Margin. In addition, Independent Amounts can be requested by one of the parties.

Commitment approach : The method used to calculate the exposure of a portfolio by adding the value of direct positions to the value of the underlying positions for all derivative transactions associated to the portfolio. For example, the exposure associated to a CDS for €1 million of stock translates into an exposure of the same amount – instead of only the one associated with the collateral posted to take the position.

Excess margin :This represents an additional amount coming on top of the margin call as established by the CCP or by usual valuation method.

Grandfathering/grandfather clause : A legal term used to describe a situation in which an old rule continues to apply to some existing situations, while a new rule will apply to all future situations. It is often used as a verb: to grandfather means to grant such an exemption. Frequently, the exemption is limited; it may extend for a set period of time, or it may be lost under certain circumstances.

Initial margin or initial margin requirement : The collateral that is deposited by the clearer at the CPP when an OTC derivatives transaction is agreed between two parties and then cleared by a CCP. What is called independent amount in the case of non-cleared OTC transactions becomes an initial margin requirement in the case of cleared transactions.

Margin call : An investor receives a margin call from a broker or clearer (cleared OTC) if one or more of the securities it has bought (with borrowed money) decreased in value past a certain point. The investor is then forced either to deposit more money in the account or to sell off some of its assets.

Variation margin :Variation margin is paid by clearing members on a daily or intraday basis in order to reduce the exposure created by carrying highly risky positions. By demanding variation margin from its members, clearing organisations are able to maintain a suitable level of risk and cushions against significant devaluations.